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Campos Calls for Pilot Program on Small Company Compliance with Section 404

SEC Commissioner Roel Campos told the International Organization of Securities Commissions Standing Committee No. 1 that he favors further study of Sarbanes-Oxley section 404 and PCAOB Auditing Standard No. 2, together with a delay in the implementation of section 404 for nonaccelerated filers. Campos called for a small company pilot program to help analyze the costs and benefits of compliance. He said he would support a further delay in compliance for nonaccelerated filers of up to 18 months to allow time to gather and analyze data obtained from a pilot program. Campos' remarks were posted on the SEC's Web site.

Campos confessed that section 404 is one of the most difficult issues that he has faced as a commissioner because it provides tremendous benefits while imposing significant costs. The SEC is preparing for its May 10 roundtable with the PCAOB to discuss the second year experiences with section 404. Campos said it is absolutely necessary to get it right.

Campos cited a number of studies, one of which predicts that the average costs of section 404 will decline by 39% for smaller companies and 42% for larger companies in year two. He also noted that a record number of small companies filed with the SEC in 2005. Campos said that 881 small companies registered new stock issues that raised $16.3 billion in capital, based on research done by SME Capital Markets. Many small companies recognize that even with the costs of section 404, there is no better option for raising capital.

Campos expressed concern about the draft recommendations of the SEC's Advisory Committee on Smaller Public Companies because they would create a two-class system under section 404. An exemption may actually hinder small company business growth, he explained. Robust internal control systems help companies discover and correct inefficiencies, and that will provide cost savings over the long-run, according to Campos. If the incentives to create and maintain effective control systems are removed, Campos said it would be more difficult for small companies to identify material weaknesses and to grow in a global and highly competitive market.

Smaller public companies represent 80% of all public companies today, Campos added, and exempting them from the section 404 requirements might undermine investor confidence. He pointed out that smaller companies already are perceived to be riskier and less transparent investments. Campos also cited a recent study which found that smaller companies are more likely to issue so-called stealth restatements of their financials which do not include amendments to previous filings. The stigma of being less transparent and less regulated could make it more difficult for smaller companies to attract investors and to raise capital, he said.

Campos said he is troubled by the disproportionate focus on costs in the debate over section 404, given that significant benefits have also been widely noted. A number of investor groups have said they are willing to bear the costs of section 404 compliance, he added. Campos does not believe the information-gathering phase of the debate has been completed. He believes a pilot program would provide the quantitative and qualitative information that is needed to make a more informed decision. The information gained through a pilot would help other small companies and accounting firms go through the implementation process for the first time, he said.

Campos said that additional guidance may also be needed, especially with regard to areas in which the scope of testing under Auditing Standard No. 2 could be narrowed and where auditors may appropriately rely on company-level monitoring controls and the work of others. His multi-pronged approach could also benefit foreign companies that are listed in the U.S. markets, according to Campos. He acknowledged the concerns that section 404 may reduce the willingness of foreign issuers to come to or stay in the U.S. capital markets, but noted that while the costs of entering the markets may be very significant, so are the rewards.